I had no idea that there was a market for such things…

These dealerships focus on people who need cars to get to work, but can’t qualify for conventional loans. They sell aging, high-mileage vehicles at prices well above Kelley Blue Book value and provide their own financing. As lenders of last resort, they can charge interest at three times or more the going rate for regular used-car loans.

Many require customers to return to the lot to make their loan payments — that’s why they’re called Buy Here Pay Here dealerships.

If buyers default, as about 1 in 4 do, the dealer repossesses the cars and in many cases sells them again.

The dealerships make an average profit of 38% on each sale, according to the National Alliance of Buy Here Pay Here Dealers. That’s more than double the profit margin of conventional retail car chains like AutoNation Inc.

That 38% return is higher than anything you’ll see on Wall Street these days. And investors are paying attention. But here’s the rub:

Buy Here Pay Here is also being boosted by one of the sophisticated financial strategies that drove the nation’s recent housing boom and bust: securitization. Loans on decade-old clunkers are being bundled into securities, just as subprime mortgages were a few years ago. In the last two years, investors have bought more than $15 billion in subprime auto securities.

Although they’re backed mainly by installment contracts signed by people who can’t even qualify for a credit card, most of these bonds have been rated investment grade. Many have received the highest rating: AAA.

This is the same kind of thinking that led to AIG getting AAA rating and subsequently going bust. I can’t see this investment strategy working out in the long term. It will probably be another disaster.

Read the full story at The Los Angeles Times. This is predatory lending, but what can be done about it?